Richard E. Waugh Speech - October 13, 2010

Good evening and thank you very much for inviting me to speak with you.

I'm very pleased to have the opportunity to address the UJA Federation of Greater Toronto, an organization that has such a meaningful impact on communities here, across Canada and around the world – and one of the largest fundraising organizations in Toronto.

I'm happy to see such fantastic support for the Bay Street Cabinet and to see so many friends and colleagues here.

Witnessing the financial crisis as a bank CEO as well as through my work with the IIF, where I am now Vice-Chairman; and coordinating closely with the Canadian government and Canadian regulators, gave me a unique perspective on what was happening around the world, and, of course, here in Canada.

Tonight, from that perspective, I'd like to share some of my thoughts on our Canadian system – on what we did right – and on what lies ahead and how we can take advantage.

Canada's performance during the financial crisis and relative strength in the wake of the global recession have garnered our country global attention. While Canada was not immune to the recession, we endured better than others.

This past June, the federal government reported that the decline in Canada's output was the smallest of G-7 countries, and that by that time we were the only G-7 country to have virtually recouped the loss.

That's not to say that there aren't still major challenges in the global recovery. We were aware that the recovery could be slow and difficult, particularly in Europe and the U.S., and we're seeing that taking place.

But despite the recent downgrades in Canada's economic forecast by the federal government and the IMF, we're still poised to lead the G-7 in cumulative growth over this year and next.

Overall, Canadian banks fared relatively well during the financial crisis and continue to be strong. That's why I call myself a cautious optimist.

Our currency is also strong, and we are among the top places in the world to invest.

In fact, the "Canadian brand" has never been stronger on the world stage than it is right now.

Some of you may remember that in 1995, the Wall Street Journal ran an editorial with the headline "Bankrupt Canada?" It stated "Turn around and check out Canada, which has now become an honorary member of the Third World."

A lot has changed, and in particular our financial system is now widely viewed as a model for other countries. Instead of asking where did Canada go wrong... people began asking what did Canada do right.

My caution is on world growth and over regulation, which I will mention shortly.

I'd like to start by discussing why our system fared well during the crisis and led us to the position that we're in.

Our system is strong from top to bottom. We have good public governance, strong fiscal, monetary and regulatory oversight and good, prudent management of our financial institutions.

At the top, Canada has a solid macro-economic policy framework that has produced excellent results. Our debt levels have remained manageable and they are among the best of the G-7.

We've also benefited from consistent and effective monetary policy that has shown a firm grasp of the issues and has kept inflation low and stable.

Our national, federally regulated banking system is very well structured. The Bank Act is strong and comprehensive, but it also allows for change and evolution, which is a necessary component in today's world.

Reinforcing our structure is strong oversight from OSFI, who work independently, but who are open to dialogue with the banks. We also have good dialogue with the Bank of Canada and the Ministry of Finance.

To further strengthen our already strong regulatory standards, OSFI retained proven safeguards, such as leverage ratios and additional capital buffers, intensive onsite inspections and its own self and peer evaluations on performance.

One of the key components to Canada's success has been our mortgage market, which is fundamentally different from that of the U.S. in structure and philosophy.

The government and the Bank of Canada have ensured a unique, conservatively structured mortgage market through CMHC and other safeguards.

Many American banks did not hold any of their mortgages on their books. They initially sold them without even meeting the customers or trying to establish a relationship. They just wanted the quick and certain fee.

Canada's financial system and strong capital encourage banks to hold mortgages – to know our customers and establish deep relationships with them – to ensure the mortgages are of high quality and to ensure that our depositors and shareholders are not at risk.

For similar reasons, Canada doesn't have the "originate to distribute" model that dominated many American and European banks and led them to securitizing much of their lending portfolios. Instead we focused on keeping good assets on our balance sheet and the capital to support them.

It also meant that we remained accountable for the risks that we underwrote, ensuring sound underwriting, documentation and monitoring. A very traditional, prudent and profitable banking model, yet very competitive in Canada and around the world.

It's important to note that no government regulation or policy prohibited us from using securitization for the sale of assets, or investing in toxic assets, like U.S. sub-prime mortgages, CDOs and so on. We just chose not to do it because of our unease with the risks.

One of the lessons that emerged from the crisis is that no amount of regulation can replace sound management and principles-based governance, or a board and management who are accountable for results to all stakeholders.

It's a prudent point of view that lies at the heart of Canada's strength, and a key component of our strong Canadian brand.

Now that we have looked back at how we arrived at this point, I'd like to take a look ahead to where things are headed in terms of the global regulatory environment, and what it means for us in Canada.

Canada's strength during the crisis gave us a platform to speak on important regulatory issues.

Over the past several months, including here in Toronto at the G-20 where our point of view received heightened attention, Canada's government leaders, policy makers and regulators have taken a lead position to protect Canada's interests while still working to implement appropriate regulatory reforms.

Although there is still much left to be decided, recent regulatory developments suggest that Canada's voice is being heard. Some of the more extreme proposals, particularly related to capital and liquidity, have been moderated.

Many more proposals are in the works and at various stages of implementation, led by the Financial Stability Board and being carried out by the Basel Committee, the IMF, the IIF and other organizations. We are not at the end of regulation, only the beginning.

One of the key recent announcements relates to Basel III capital and liquidity requirements to be ratified at the upcoming G20 meeting in Seoul, which are very manageable for Canadian banks, and put us in strong position in terms of the relative ease by which we'll be able to comply.

There are several other areas of focus being worked on which still pose significant challenges.

Counter-cyclical capital proposals, which aim to moderate the extreme ups and downs and ensure that capital is there when it is needed most, are still largely academic concepts. They will require more work to turn them into practical solutions that can be appropriately implemented.

I am concerned that the regulators are relying too much on their models and rules.

Proposals for contingency capital are also being looked at – and in fact the Basel committee may include Canada's debt-to-equity conversion proposal in the suite of reforms slated for the G-20 summit in Seoul, which would be an important global endorsement of a prudent Canadian solution.

Challenges also surround SIFIs – in terms of what makes a firm systemically important – and who gets to decide. More capital will be required for these firms.

While these issues continue to be worked through, the larger issue remains one of ensuring global coordination and balance.

Questions remain about how to ensure a level playing field when implementation will be different across each jurisdiction, some of which were hurt much worse than others in the crisis.

Compounding the issue is the heightened political involvement in banking regulation and oversight, which can be unpredictable and adds to the uncertainty.

What will the consequences be for international banks which are subject to local rules in each country where they operate, particularly when in some cases those rules are very protective?

There are implications not only for day to day business but also for cross-border resolution in the case of a bank failure, where there will need to be an orderly way for the bank's assets to be distributed.

As each country goes down its own path of regulatory implementation, there is a need to look ahead and ensure that everyone is walking together.

We've already seen examples of individual countries implementing rules set out by the FSB and Basel.

In the United States, Dodd-Frank marks the beginning of a new, tighter regulatory regime that will have a lasting effect on the financial landscape.

For larger institutions, challenges will come as a result of provisions in the Act that address the "too big to fail" issue, such as higher capital requirements and the threat of special fees in the event of a systemic failure.

This inherent bias against larger firms may create incentive for some of them to reduce in size to avoid the larger size classification.

Dodd-Frank will significantly raise the cost of compliance and may make it more difficult for some financial institutions, particularly smaller ones, to remain profitable. It's predicted that many banks will change their business models or downsize, as they become increasingly weighed down by regulatory requirements.

As part of that legislation, the Volcker rule that limits proprietary trading has already resulted in many major U.S. banks laying off proprietary trading staff in anticipation of the coming implementation of the provisions.

In Canada, the strong regulatory framework we've had in place for many years – and continue to strengthen – has prepared us well, and now others around the world are faced with the task of coming up to our level. That's a significant advantage. We do not plan on significantly changing our business model.

My concern is that in the regulator's zeal to create a safe and prudent banking system, we have sacrificed growth and jobs. The significant capital increases are very significant and will require significant global capital for many European and American Banks.

This may lead to reduced lending, especially to small business and the housing market. It is essential the policy makers and regulators find the right balance. This could adversely affect global growth and we in Canada will not be immune.

We don't know where the next crisis is going to come from and history tells us that the next one will be different from any previous ones.

While appropriate regulation is important, a foundation of good governance and good risk management like we have in Canada is the best defence against future crises.

As I've mentioned, there is still much work to be done to address uncertainty. For Canada's part, our government has done tremendous work on our behalf and we should be supportive of their efforts. It's not easy to manage global issues like this.

We can be confident of Canada's position. Our banks are strong and our country is on solid footing and we have several highly developed, world class sectors to build upon. We also enjoy a very high standard of living, a diverse workforce and a society of unparalleled rights, freedoms and tolerance.

For Scotiabank, we are well positioned to take on the challenges of this new era, but we can't be complacent. We must take advantage of our strengths.

We've just announced a significant reorganization to include a new business line "Global Wealth Management", all to take advantage of a window of opportunity. We will also accelerate initiatives in Scotia Capital around the world.

But Canada's relatively small size means we have a big challenge ahead of us to compete and have influence in a world increasingly dominated by large emerging market economies.

We must continue to pursue free trade agreements, and promote the strong Canadian brand to give Canada increased profile in business opportunities abroad.

In the private sector, our companies must devise bold plans for taking their expertise abroad, to actively seek new international markets for products and services, and look to find a niche in emerging markets.

We have an opportunity to use Canada's strong brand to position ourselves for future success, but we must act now. The window will close.